The following invention relates to a system and method for matching buy and sell orders in securities and, in particular, to a system and method of improving the speed and price at which such securities transactions take place while maintaining the confidentiality of any given buy and sell order.
Buyers and sellers of securities have many avenues through which to trade. Depending on the type of security, a trade between a buyer and seller may occur on one of several markets including the New York Stock Exchange (“NYSE”), the American Stock Exchange (“AMEX”), the National Association of Securities Dealers Automated Quotations system (“NASDAQ”) or via any number of ATSs, including electronic communications networks (“ECNs”), that match buyers and sellers. Buyers and sellers generally present their orders for execution on one of these markets through a broker associated with a financial institution that communicates directly with the markets. Thus, financial institutions act as an interface between customers desiring to trade in a particular security and the financial markets in which the trade will be executed.
In addition to servicing order flow on behalf of its customers, a financial institution may also trade in the financial markets on its own behalf, for example, by engaging in program trading or trading to manage the financial institution's overall risk. Orders placed on behalf of the financial institution's proprietary accounts are also forwarded to the financial markets for execution.
Although access to the financial markets is vital for a financial institution to service its customer and proprietary order flows, sole reliance on the financial markets for order execution is sometimes inefficient. First, financial institutions incur a fee for each transaction executed in the financial markets on its behalf. In many cases, however, the financial institution will pay this transaction fee even though it controls both the seller's and buyer's orders in a particular transaction. In such a case, the financial institution could have eliminated the fees associated with such a transaction by not using the financial markets to execute the transaction and matching the buyer and seller internally. Aside from unnecessary transaction costs, routing orders externally for execution often results in slower execution times as opposed to orders that are matched within the financial institution itself.
Customers often place various restrictions on orders placed with a financial institution. For example, if an order to transact in a security at a particular price is designated by a customer as a “held” order, then the trader receiving the order is subject to certain obligations with respect to executing such an order. There are two types of held orders. With a held market order, the trader is obligated to buy/sell the particular security at the prevailing market price as quickly as possible. With a held limit order, the trader is obligated to attempt to buy/sell the security at the limit price or better. In contrast, if the customer designated the order as a “not held” limit order, then the trader may buy/sell the security at the limit price or better, and within a time period subject to the trader's discretion.
A financial institution is obligated to seek the best execution for a particular customer order. To meet its obligation, the financial institution is generally not limited as to the forum in which it may transact and generally routes the order to any of a number of external markets in order to get the best execution price.
In contrast, orders may have restrictions with respect to what forum the financial institution may use to transact. For example, if an order is designated by a customer as a “cross only” order, then the financial institution cannot route these orders to external financial markets for execution and must instead attempt to execute the trade using another customer of the financial institution as a counterparty. If an order is designated as a “do not represent” order, then the financial institution cannot show interest to potential counterparties. A customer may designate an order as “cross only” and “do not represent” so that the customer's intentions to transact in the security do not affect the market for the particular security. In this way, customers can have their orders executed by the financial institution while still maintaining confidentiality.
Customers placing “cross only” and “do not represent” orders, however, have to weigh the benefits of maintaining order confidentiality against execution price and speed. Because the financial institution cannot present “cross only” and “do not represent” orders to the public markets, these orders may not be executed as quickly or at as good a price as orders exposed to external markets.
Prior art systems exist for matching buy and sell orders in a particular security. These systems, also called crossing networks, match buyers and sellers using any of a number of algorithms. For example, POSIT, a crossing network owned by ITG, Inc., matches buyers and sellers at the midpoint of the prevailing national best bid and offer (the “NBBO”) in NASDAQ or CQS. For example, if the POSIT system has a buyer desiring to buy XYZ Corp. stock at a limit of $25 a share and a seller wishing to sell XYZ Corp. shares at a limit of $20, then POSIT will execute a transaction between the buyer and seller at a price which is the midpoint of NBBO. Therefore, if NBBO is $23 bid by $25 offer, then the midpoint of NBBO is $24 and the match between the buyer and seller occurs at $24. If, however, NBBO is $22 bid by $24 offer, then the midpoint of NBBO is $23 and the match between the buyer and seller is at $23. If, however, the midpoint of NBBO is $26, then the POSIT system will not execute a trade between the buyer and seller. Thus, because the POSIT matching algorithm only executes trades at the midpoint of NBBO, it does not necessarily provide an opportunity to trade even if buyer and seller would otherwise match.
Another prior art strategy used to match buyers and sellers, one that is used by several ECNs, is to trade at the bid/offer price of the first counterparty to post an order to buy/sell a particular stock to the ECN. For example, if a buyer posts a bid to buy XYZ Corp. shares at $25 per share and subsequently a seller posts an offer to sell those shares for $22 each, then the transaction favors the seller and occurs at $25. Conversely, if a seller posts an offer to sell XYZ Corp. shares at $22 per share and subsequently a buyer posts a bid to buy those shares for $25 each, then the transaction favors the buyer and occurs at $22. Thus, under this algorithm, the second party to a transaction is favored to the detriment of the first party.
Yet another prior art strategy for matching buyers and sellers exists in which trades in a particular security between buyers and sellers occur at the NYSE closing price for the security. This approach, used in the Instinet's aftermarket system, does not offer a price improvement to either buyer or seller.
Accordingly, it is desirable to provide a method and system that improves the execution speed and price at which customer buy and sell orders transact while maintaining the confidentiality of any designated order.